DBRS Morningstar Downgrades Credit Ratings on Two Classes of Morgan Stanley Capital I Trust 2017-H1, Changes Trends on Eight Classes to Negative From Stable

DBRS Limited (DBRS Morningstar) downgraded the credit ratings on two classes of Commercial Mortgage Pass-Through Certificates, Series 2017-H1 issued by Morgan Stanley Capital I Trust 2017-H1 as follows:

-- Class F-RR to B (high) (sf) from BB (high) (sf)
-- Class G-RR to B (low) (sf) from B (high) (sf)

DBRS Morningstar also confirmed the credit ratings on the following classes:

-- Class A-2 at AAA (sf)
-- Class A-3 at AAA (sf)
-- Class A-4 at AAA (sf)
-- Class A-5 at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-A at AAA (sf)
-- Class B at AA (high) (sf)
-- Class X-B at AA (low) (sf)
-- Class C at A (high) (sf)
-- Class X-D at A (sf)
-- Class D at A (low) (sf)
-- Class E-RR at BBB (sf)
-- Class H-RR at CCC (sf)

DBRS Morningstar changed the trends on Classes B, C, D, E-RR, F-RR, G-RR, X-B, and X-D to Negative from Stable. The credit rating assigned to Class H-RR typically does not carry a trend in commercial mortgage backed securities (CMBS) ratings. All other trends remain Stable. The ratings downgrades and Negative trends are reflective of the increased loss expectations for two loans in special servicing, including the 1615 Poydras loan (Prospectus ID#11, 3.1% of the current pool balance), which recently transferred to the special servicer in July 2023 for imminent monetary default but has defaulted on its June 2023 payment. The loan is secured by an office property in New Orleans and the borrower has expressed its intent to transition ownership of the asset. The second loan in special servicing is the One Presidential loan (Prospectus ID#13, 2.9% of the currently pool balance), which is secured by an office property in the Philadelphia suburb of Bala Cynwyd, Pennsylvania. The loan is real estate owned and the updated June 2023 appraisal noted a value of $20.0 million, a decline from the January 2022 value of $22.2 million and issuance value of $50.0 million. Both of the specially serviced loans were analyzed with liquidation scenarios, resulting in an aggregate loss in excess of $30.0 million. Additional details on these loans are highlighted below. The pool is concentrated by property type with loans backed by office properties representing nearly 40.0% of the pool balance, which also includes the above-mentioned specially serviced loans. In general, the office sector continues to be challenged because of rising vacancy rates in many submarkets and the decreased investor appetite for this property type considering the shift in workplace dynamics. Loans that have exhibited increased credit risk were analyzed with stressed scenarios, resulting in a weighted-average (WA) expected loss that was more than 35.0% higher than the pool average. The erosion in credit support from the loss expectations of the two specially serviced loans and the office loan exposure suggests downward pressure in the middle to the bottom of the capital stack, therefore supporting the ratings downgrade and Negative trends. The rating confirmations reflect the overall stable performance of the remaining loans in the pool as exhibited by the WA debt service coverage ratio (DSCR) that is approximately 1.75 times (x) based on the most recent year-end financials.

As of the September 2023 remittance, 54 of the original 58 loans remain in the trust, with an aggregate balance of $976.7 million, representing a collateral reduction of 10.4% since issuance. Six loans, representing 4.1% of the pool are fully defeased. Three loans, representing 7.9% of the pool balance, are in special servicing and 14 loans, representing 20.1% of the pool balance, are on the servicer’s watchlist, six of which are being monitored primarily for declines in occupancy rate and/or DSCRs.

The largest loan in special servicing is 1615 Poydras, which is secured by a Class A office property in the central business district of New Orleans. The loan transferred to the special servicer in July 2023 for imminent monetary default and has defaulted on its June 2023 payment. According to the servicer, the borrower is expected to engage a broker to market the property for sale through the end of the year but if the price is acceptable to the lender, the title will transfer to the trust.

Occupancy has been trending downward, with the June 2023 occupancy rate at 53.0% compared with the YE2022 figure of 82.9% and issuance figure of 81.2%. Freeport McMoRan Services Company was the largest tenant at issuance and occupied 41.9% of the net rentable area (NRA) on a lease through April 2026. However, its lease was structured with a partial termination option in April 2021 when the tenant could give back approximately 45,000 square feet of its space, as well as a full termination option in April 2023 for the entirety of its space: it appears that both termination options were executed and the tenant is no longer at the subject property. According to the issuance documents, the estimated termination fee for both options was approximately $3.0 million. DBRS Morningstar has requested confirmation from the servicer on whether the fee was collected. The largest tenant is currently DXC Technology Services LLC (DXC), which currently leases six floors (representing 26.8% of the NRA on a lease through October 2031) but only occupies three of those floors. The three dark floors along with another floor currently occupied by DXC (collectively representing 17.2% of the NRA) are listed as available for sublease.

According to an article published in September 2023 by Biz New Orleans, Shell announced its plans to relocate from its Poydras Street location at One Shell Square to a new office property in the River District Neighborhood expected to be completed by late 2024 or early 2025. Furthermore, per Reis, office properties in the Central New Orleans submarket reported a vacancy rate of 18.0% in Q2 2023, which has remained relatively static since Q2 2021. Given the low in-place occupancy, eventual departure of a prominent tenant from the vicinity, and generally soft submarket, the value of the property has likely declined from issuance when it was appraised at $55.3 million. Given the significant deterioration of the subject’s recoverability prospect, this loan was analyzed with a liquidation scenario based on a stressed haircut to the issuance value. The resulting loss amount was nearly $18.5 million with a loss severity in excess of 55.0%, which erodes most of the non-rated first loss piece in the bond stack.

The second loan in special servicing is the One Presidential loan (Prospectus ID#13; 2.9% of the currently pool balance), which is secured by an office property in the Philadelphia suburb of Bala Cynwyd, Pennsylvania. The loan transferred to the special servicer in November 2021 for imminent monetary default and the property became REO in December 2022 with the last payment received in January 2023. The special servicer and broker are currently working on leasing up the property in anticipation of a sale. The former largest tenant, Hamilton Lane Advisors, LLC (Hamilton Lane Advisors; 39.1% of the NRA), vacated the subject at its December 2021 lease expiry, resulting in the occupancy rate dropping substantially to about 50%. The loan is structured with a cash flow sweep that is initiated two years prior to the tenant’s lease expiration. According to the September 2023 loan-level reserve report, $25.6 million was held in a special rollover reserve that may be tied to Hamilton Lane Advisor’s departure, but DBRS Morningstar has requested confirmation from the servicer. Based on the March 2022 rent roll, Pep Boys executed a lease to backfill the majority of the Hamilton Lane Advisors space beginning in June 2022, bringing the occupancy rate up to about 80.0%. Pep Boys was already occupying 11.2% of the NRA with a lease that expired in July 2022, but based on the June 2023 appraisal, the lease was renewed beginning in January 2024 through to January 2029.

Despite the leasing momentum and substantial amounts currently held in reserve, the value of the property based on the June 2023 appraisal has declined to $20.0 million from the January 2022 value of $22.2 million and the issuance value of $50.3 million. For this review, this loan was analyzed with a liquidation scenario, resulting in a loss amount approaching $15.0 million and a loss severity in excess of 50.0%.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (July 4, 2023) https://www.dbrsmorningstar.com/research/416784.

Classes X-A, X-B, and X-D are interest-only (IO) certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the North American CMBS Surveillance Methodology (March 16, 2023; https://www.dbrsmorningstar.com/research/410912).

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit ratings assigned to Classes B, C, and D materially deviate from the credit ratings implied by the predictive model. DBRS Morningstar typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit ratings would consider a three-notch or more deviation from the credit rating stresses implied by the predictive model to be a significant factor in evaluating the credit ratings. The rationale for the material deviations is the uncertain loan-level event risk tied to the loans in special servicing, as well as the notable office concentration in the pool and loans on the servicer’s watchlist, and where applicable, loans were analyzed with a conservative approach to provide additional cushion. Considering an updated value was not available for 1615 Poydras, DBRS Morningstar stressed the issuance value of 1615 Poydras given the performance decline and challenged office market. In addition, the stable performance of the pool is exhibited by a healthy WA DSCR of 1.75x. Based on the analysis, the tranches that are most exposed to loss were downgraded and the downwards pressure through the middle to bottom of the capital stack carries Negative trends.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar Long-Term Obligation Rating Scale definition indicates that credit ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and credit ratings are monitored.

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The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology/North American CMBS Insight Model v 1.1.0.0 (March 16, 2023), https://www.dbrsmorningstar.com/research/410913

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://www.dbrsmorningstar.com/research/420984)

North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://www.dbrsmorningstar.com/research/419592

Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023), https://www.dbrsmorningstar.com/research/415687

Legal Criteria for U.S. Structured Finance (December 7, 2022), https://www.dbrsmorningstar.com/research/407008

A description of how DBRS Morningstar analyzes structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/417279.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.